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Business Tax

Dividends vs deemed dividends

Dividends vs deemed dividends
Sumire Uemura
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What is a dividend?

ITAA 36 defines a dividend as 

  • any distribution of profits made by a company to its shareholders
  • any amount credited by a company to any of its shareholders due to their shareholding

Dividend Imputation System

The dividend imputation system is a tax mechanism used in Australia to avoid double taxation of corporate profits distributed as dividends to shareholders. Under this system, shareholders receive dividends with imputation credits, also known as franking credits. These credits allow shareholders to offset the tax they owe by the amount already paid by the company.

For instance, if a company's tax rate is 30% and it pays out $1000 of pre-tax profits as dividends to a shareholder, the profit will be taxed at 30% within the company. Consequently, the shareholder is entitled to receive $700 of cash dividends and $300 in imputation credits.

In this case, the shareholder will include the full $1,000 of grossed up dividends in their assessable income, and they can offset $300 from their tax payable by utilising the imputation credits received from the company.

Note that the imputation credits are only attached to franked dividends. Unfranked dividends, which are dividends not previously taxed by the company, do not come with any imputation credits.

Share Capital Tainting Rules

The share capital tainting rules restrict companies from distributing tax-free dividends disguised as returns of capital. 

Deemed Dividends

Deemed dividends are notional dividends that are treated as actual dividends for tax purposes, even if they are not formally declared or paid by a company to its shareholders.

Notable regulations regarding deemed dividends provided by ITAA36 are as follows:

  • Section 109- Excessive Payments
  • Division 7A - Loan to Shareholders
  • Bonus share issues

In the next article, we will describe each regulation and the limit of deemed dividends.

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